Is "Stupid" Money Chasing Millennials in Your Market?

[Michael Ealy]

Have you heard of the expression "stupid money"? It is when a herd of investors or speculators seem to be overpaying for an asset.

In my market in Cincinnati and I guess almost everywhere in the country, "stupid money" seems to be overpaying for apartment buildings. We've seen cap rates drop several basis points in a short span of time.

At first, I thought "stupid money" is really dumb - overpaying for buildings but...it seems that it's not "stupid" at all. Money is flowing into apartment buildings because it seems Millennials across the country are now preferring to rent long term vs. buy. 

In my local market, I've seen movement of people from the suburbs back into the city as well.

Keep in mind some of that "stupid money" is from institutional investors and private equity firms with full time acquisition analysts and market experts (not newbies like here on BP). For example, a lot of them paid 9% cap for buildings in C areas in Cincinnati less than 5 years ago and the cap rates are now 6-7%. 

Crazy!

Have you seen this in your local market as well? "Stupid money" chasing the Millennials' trend to rent apartments as a long term housing solution vs. buying?

If so, share it here. Also, if you are, share how you are making money from apartment buildings today.

If I get quite a few responses, I might share how I make money with apartment buildings today...even if I seem to be "overpaying" for them.

[Alan Grobmeier]

A number of millennials can't afford a date according to this article.  Not sure how you can buy a house if you can't afford a date?

https://www.usatoday.com/story...

[Ralph Stowe]

It's been happening in our city for years now. Every time you turn around, a new apt building is going up in places you didn't think building was even possible. Old office building are now luxury condos. Another developer just cleared out 16+ acres to probably put in 500+ more units.

[Alan Grobmeier]

It seems to me that we are in 'uncharted territory'.  It appears that we are going to have 'QE Forever' and a continually devalued dollar.  Literally a race to the bottom.  At least until the next 'recession', whenever that MIGHT occur.  Our banking system is going to pull out every stop possible to keep another GFC from happening again.  At the same time, though, it's all built on a house of cards/credit.  

The EU has already resorted to negative interest rates.  And it's not really helping.  Is Deutsche Bank the canary in the coal mine for the next round?

The worst part about it is that all politicians, Reps & Dems, are ok with kicking the can down the road.  :-(

[Scott Trench]

One interesting thing to note about low cap rates is that they actually dramatically increase the returns of a great operator buying multifamily, assuming the cap rates don't change.

Example: 

Apartment for sale. $400K in NOI. 4% Cap Rate. $10M Price.

You buy it with some LPs. You put down 30%, $3M, and increase rents and decrease OpEx with $2.5M in Capital improvements. Financed $9.5M in debt. Property generates $600K in NOI at the end of year 2 going into year 3. You complete this over two years and sell at the end of year 3 with a full year of NOI at the new higher level.

Well, now your asset is worth $15M at a 4% cap rate. If you and your LPs put 30% in equity, $3M, then you liquidate $6.5M net of debt, plus your ~$1.3M in cash flow, for a total of $7.8M returned on $3M in equity (and that's before loan amortization). Pretty solid to 2.5X+ your equity in three years.

Now let's try the same project at a 10% Cap rate:

$400K in NOI. $4M Price. You put down 30% - $1.2M - and increase rents and decrease OpEx with a $2.5M in CAPEX to achieve $600K in NOI in year 3. You've financed the acquisition and CapEx with $5.3M and you plan sell at the end of year 3. In this sceneario, you will generate ~$1.3M in NOI during the hold, and your equity value increases to $6M. Not factoring in loan amortization, you'd generate $700K in proceeds net of debt from the sale, and $1.3M in cash flow during your hold period. That's $2.0M returned to investors on $1.2M down. This is a far less attractive (but still good) 66% return over three years than the case above.

Certainly, low cap rates come with increased risk - when cap rates rise, the investors playing the first game will get washed. That's a risk that is understood, and why you might not want to play this game with money you can't afford to lose. But, if they stay low, major acquisitions and remodels begin to make a whole lot of sense, in ways they never will in a 10% Cap Rate environment.

Just ask @Ben Leybovich how this is working out in Phoenix for him.

[Bill F.]

Originally posted by @Alan Grobmeier:

It seems to me that we are in 'uncharted territory'.  It appears that we are going to have 'QE Forever' and a continually devalued dollar.  Literally a race to the bottom.  At least until the next 'recession', whenever that MIGHT occur.  Our banking system is going to pull out every stop possible to keep another GFC from happening again.  At the same time, though, it's all built on a house of cards/credit.  

The EU has already resorted to negative interest rates.  And it's not really helping.  Is Deutsche Bank the canary in the coal mine for the next round?

The worst part about it is that all politicians, Reps & Dems, are ok with kicking the can down the road.  :-(

You know that the last round of QE was in Sep of 2012 and the Fed began letting securities expire without reinvesting them in Nov 2017, right?

The Fed's balance sheet has shrunk by 14% since Nov 2017 or by about 8.4%/yr.

QE and the Fed Funds Rate are two different tools of monetary policy.

[Michael Ealy]

Originally posted by @George Gammon:

@Michael Ealy Interesting question, "Is stupid money chasing millennials in your market." 

There are some really solid answers on this thread @Russell Brazil @Greg Dickerson, but I'd like to expand on their points slightly.  

The Fed has created an environment of artificially low interest rates which starves several groups of yield.  As we all know, it makes it much more difficult for managers of large pooled groups of money to provide an acceptable return to their investors.

These groups include hedge funds and private equity funds.  Most would respond with "boo hoo," the poor billionaires, what will they do.  But the further you dissect the problem you see it's not just billionaire run hedge funds, but public/private pension funds, insurance companies, teachers unions etc.  

All of these groups, and more, are starving for yield and they'll do almost anything to get it...including going out much further on the risk curve than is prudent.  

Adding fuel to the risk curve fire are the funds in Europe and Japan where rates are not just artificially low, they're negative.  That's right, believe it or not, there's 13 trillion dollars of negative yielding sovereign debt (and recently European corporate debt), floating around the world wide financial system, formerly the bedrock of most funds portfolios.  

In other words, there's upwards of 13 trillion no longer able to buy bonds. See chart

So what do you do if you're a fund manager?  Go to cash?  Do you think your investors will continue to pay you 2% and 20% management fees to be in cash?  They really have no choice but to be fully invested.  

Bonds are not an option so do you go into stocks?  Maybe, but where?  US market is at all time highs and in the longest period without a recession in US history.  European banking (Deutsche Bank) is shaky at best and Australia/Canada are on the verge of having their housing bubbles pop.  

My point is, all things considered, if you have to put large amounts of money to work, multifamily with a 6% cap looks pretty darn good.

Which by no means implies there's little risk, or all the "professionals" working for them know something you don't.  It simply means they have no choice but to go further and further out the risk curve.  

Just because they go further out the risk curve doesn't mean it's less risky! ;) 

IMO this may have something to do with Millennial housing preferences but it has much more to do with interest rates being at 5000 year lows and 13 trillion in negative yielding sovereign debt.  

My suggestion would be don't compete with them, there's far greater downside than upside.  If you have to buy US assets, buy them with 30 year fixed rate debt.  It's cheap and not available to the hedge funds and private equity.  

30 year fixed rate mortgages are by far, the biggest edge small investors have based on current market conditions.  

George 

 George, awesome response to this discussion. I didn't realize negative interest debt is that large. I know it's large but your data shows it's mind-bogglingly HUGE!

No wonder there is so much pressure on institutional investors to invest in real estate.

One can lament that it's hard to find good deals or one can modify how one finds good deals and then find a good deal for these institutional investors. In other words, be a buyer during a buyer's market and be a seller in a seller's market.

Thanks again. If I could vote for your post more than once I would.

[Michael Ealy]

Originally posted by @Jim K.:

@Michael Ealy

You know my strategy, Michael, poking around ugly places to find the pocket solid C'class neighborhoods in borderline D'class areas, buying SFR at D'class price, renovating to solid C'class standard, renting for low market rates to very-well-screened tenants looking for long-term housing.

For various tax reasons, the entire area I'm investing in is getting a significant increase in its public budgets, municipality and school district. The pocket neighborhoods I'm talking about are coming back and appreciating quickly -- a couple of big local flip teams are concentrating hard on those pocket hoods, because they know their business. Since I got there first, God bless the sweet hearts of the flippers.

The stupid money is going into what I call "the high hood."

I really get the sense that there are dozens of realtors out there taking the comps off the flipped houses in the pocket neighborhoods and applying them to EVERY house in the area for OOS investors. To give you an example: in the same municipality, I own a house on Peach Street, I would own every house on that street if I could expand fast enough. I own a house on Judy Street, that one's much more of a questionable buy, but I believe it has potential. But I will not buy a house on Diana Street, I don't care how cheap it is. Because all the locals all know the triangle of Diana Street, Joanna Street, and Barbara Street is a place to avoid, the worst nexus of the high hood where the local drug trade lives and breathes.

Yet Diana, Joanna, Barbara Street houses are still getting sold to OOS and institutional investors.

The other thing that's happening is that people are buying cheap-construction properties in the same hoods for inflated prices, stuff that's obviously heading for a teardown. My strategy is simple: pre-1945, I want brick and only brick. If I can get it, I want first-quality brick. I want steel beams and lally columns in the basement. I want as little major renovation by third parties in these buildings by others since construction as I can get.

But the same OOS investors are buying the dogcrap, saggy beams and rebuilt columns, dirt cellars, houses that have been flipped a dozen times since 1980, really, really dumb investments to turn into rentals.

 Totally agree with you.

Real estate investing is extremely local - down to the street or block level. In Cincinnati for example, we have a part of the city called Avondale. One block - you can be in a war zone...and just a few blocks away, you are in a hot development. 

I bought a piece of land there that I am developing right now. When I did my underwriting, I was assuming the rent I can charge is $900/month for a 2-bedroom (when 2-bedroom rents were only $700/mo). People told us we're crazy. Some real estate investors said "Mike's stupid!"

Well today, I am charging $1250/month in rent for those 2 bedrooms and I have several tenants move in this month. And I structured it in such a way that if I get just 5 units rented, the debt service will be covered for the entire 40-unit development.

Who's stupid now?

Lesson: know your market intimately down to the street level and know the good pockets before other investors do. Then be in a position to act QUICKLY specially in this hot market.

[Michael Ealy]

Originally posted by @Bill F.:

Originally posted by @Michael Ealy:

At first, I thought "stupid money" is really dumb - overpaying for buildings but...it seems that it's not "stupid" at all. Money is flowing into apartment buildings because it seems Millennials across the country are now preferring to rent long term vs. buy. 

Could you point me to the research or data has lead you to this idea? All of the data I have seen points in the opposite direction so I'd like to see someone who has reached a different conclusion.

Also being an institutional investor and stupid are not mutually exclusive... Portfolio Insurance, Long Term Capital Management, Pets.com...

 Bill,

Here's what I have:

1. Millennials are broke and they can't buy houses and will delay house purchase 3-5 yrs or longer:

2. The same study found that the main reason for the delay in purchase are: (a) difficulty in saving for the downpayment and (b) monthly payment being not affordable because of not so good credit. The same study cited student loans being one of the reasons why. The huge student loan that we have in the US corroborates this. 

3. Keep in mind that Millennials started working at the start of the Great Recession so they don't make as much money as the Baby Boomers or Gen Xers when they started working (after factoring in inflation). Hence, they want to be mobile - move/relocate to cities where the jobs are. Hence, they prefer renting vs. buying. Here's a report by the Washington Post about this observation, calling it lifestyle flexibility but if you look at the details, it's all about mobility to move to where the jobs are, or where they can get a higher-paying job.

For the Baby Boomers, some of them prefer renting for lifestyle flexibility because they want to live in a community setting where amenities are provided for them and they don't have to worry about caring for their homes/ cutting the grass/ etc.

4. Washington Post is not alone in this observation. Forbes reported that Millennials account for majority of studio apartments being rented by them. With Millennials being the largest demographic group now, this is HUGE and will only grow over time.

Having said that, real estate is local - so Millennials may not be as big of a factor in your market vs. mine. But, the above data seem to be consistent with my experience buying and developing apartment buildings in my market.

[Michael Ealy]

Originally posted by @Marc Winter:

IDK, I read this 'crazy money' and low cap rate stuff and I gotta say, it's all about the total number of staws.  It's not the first one, not the last one, it's the total of the straws that will break that poor camel's back.

Example:  I have been blessed with two of the most beautiful Millenial daughters a proud papa could ever hope for.  They both earn over 6 figures.  Both added a middle name: Independent.  They both live in their own apartments in a Millenial ghetto in Brooklyn--chic is more than just an adjective to those living that lifestyle.  Rent for a 450 sq ' apt runs about $2,500 plus utilities.  Bargain, right?

Savings?  Nah, nothing more than a month's rent.  Party?  Hell yeah, bring it on!

Until, a few months ago, when #1 got married and told me she wanted to have a baby and, oh yeah, "we want to move out of Brooklyn.  Too urban, we want something more (wait for it) -- SUBURBAN. A nice place to raise a kid".  She wanted better schools, room to run and play and all the stuff that my parents wanted.   

The moral of this little tale is that this stuff goes in cycles.  Life, Real Estate, stocks, world views, love and marriage, youth and older age.  It's all cyclical.  Figure out the cycle as best ya can.  If and when that happens, we'll know which straw we are really looking at.

Cheers!

 Marc,

You may be right. Maybe this is just part of the cycle of life.

And of course one can't stay in a studio or 1-bedroom apartment when one marries and have kids.

But the data seems to point out that Millennials as a group started out as "more broke" than the Baby Boomers and the Gen Xers so they will rent longer than their counterpart.

So, it's all good for us real estate investors.

[Michael Ealy]

Originally posted by @Alan Grobmeier:

A number of millennials can't afford a date according to this article.  Not sure how you can buy a house if you can't afford a date?

https://www.usatoday.com/story...

Yup - this is consistent with the fact that Millennials as a group starts out "more broke" than the Baby Boomers and Gen Xers (by the time you factor in the real inflation rate). They started working at the start of the Great Recession after being saddled with HUGE student loan debts...so they can't afford dating and definitely can't afford to buy houses!

[Michael Ealy]

 Yup - I agree. At the end of the day, investing is like brushing your teeth. You can't borrow my toothbrush - so to each his own! However, as you pointed out, the toothbrush, regardless of its design has to work - the investment, regardless of the cap rate or what-have-you... has to make money.

All I am trying to say is that a lot of investors are complaining about these big money being "stupid" and driving prices up for them so they can't buy a good deal. Instead of complaining, go to work and MAKE a good deal. It's not 2009 anymore where you can find a good deal just by looking at the MLS. In today's market, you have to dig deeper and be more creative in creating value so you can pay a seemingly "stupid" price for an asset but increase the value of the asset so that people will realize you're not that "stupid" :)

[Account Closed]

I'm on board with that, @Michael Ealy. Building a deep network is necessary, and marketing is becoming more and more important. I operate in a much smaller space than you, it appears- working mostly in plexes. Du,tri,four,eight, etc... where data is extremely accessible, and I'm very optimistic about new investors' ability to find off market deals. 

Data is cheap, phone and web based marketing can be cheap as well. The guy or gal that wants to buy a duplex a year can probably spend $500 to market and find a good deal if they're efficient. 

And if they aren't, hell, more deals for me. 

[Michael Ealy]

Originally posted by @Bill F.:

Originally posted by @Josh C.:

@Bill F.

I’ll echo this statement that big buyers know everything. It’s flawed thinking to believe hedge funds and other big “smart” buyers can’t make mistakes. Mount helix bought around 1000 homes in Indianapolis. They never had the crews to rehab them. Got more fines more unsafe or high weeds or whatever than anyone ever had before. Then fire saled everything. Didn’t even check what it was worth. Just low low prices. I bought one such house they listed for $17k I paid $36k and was worth 80k. Even after I offered them 50k about 6 months prior. They still listed it out 17k. Just silly.

“In some corner of the world they are probably still holding regular meetings of the Flat Earth Society. We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't.”- Warren Buffet

The entire idea of the smaller investor following the lead of the "smart money" big investor is laughable. Having $10m in AUM is a separate world than $100m or $1b AUM; different universes with vastly different constraints and restraints. Each can do things the other would never dream of and still find success. Why people invoke this appeal to authority in order to justify their investment choices is beyond me.

I also think the idea that Millennials aren't buying house is simply a story investors tell to make themselves feel good about purchasing apartment they know are marginal investments. I have yet to see any data to support the claim, that's why I asked OP for his, but its been crickets from him so far...

The Millennial generation runs from 1981-1997, or 38-22 year olds. The median home buying age is 31 (in 1970 it was 30.6 if anyone cares). Assuming a uniform distribution, half of the generation is below the median age.

It is a lot like saying you need 10 years of experiences to work at a company and then comparing that you don't have anyone in their 20's working with you. Is it a surprise that 25-28 year olds are living in apartments? Would this even be a discussion 15 years ago?

This article from 2015-16 time frame has some great data to support its conclusions  that "a majority of millennials would prefer owning to renting, but they appear to be postponing homeownership because of real and perceived difficulties in affording it."

Millennials want to own homes, but for the reason listed in the articles plus some other( boomers aging in place, changes to household formation times, ect) the timeline is delayed. All of this is a far cry from millennials aren't buying homes.

Sorry for not responding sooner. I was on my way to China to meet my investors. I put some of the data I found about Millennials and their effect on apartment demand/economics.

1. I am not saying that BIG money is always smart. I totally agree that greed can come into play and BIG money sometimes buy bad deals. However, between the newbie investors here on BP who complain there are no good deals and the analysts & market experts of BIG money - my vote is on the latter.

2. I am also not saying that Millennials will never buy houses. It just seems like Millennials, due to the fact that they're starting out poorer than Baby Boomers and Gen Xers plus the HUGE student loan that they have...are more prone to renting longer. Some of them choose to rent permanently as a lifestyle given that, Millennials are also more mobile. Unlike Baby Boomers who have 1 or 2 jobs their entire career, Millennials have 1 to 2 jobs every 2 years (just anecdotal or an exaggeration just to illustrate the point).

So renting is more amenable to them as a lifestyle choice so they can move or relocate where there are higher paying jobs.

3. I am not saying that you have to follow what "stupid money" does. Smaller investors can't. I have acquired over 1,000 apartment units (closer to 2,000 now after we close on the purchase of a 370+ unit property in a few weeks) so my strategies may not work for you or smaller apartment investors. All I am saying is that instead of complaining that BIG and "stupid" money has gobbled up inventory and pushed prices upwards so there are no more good apartment deals, one should dig deeper and actually MAKE a deal.

What do I mean by this?

Let me give you an example of a 42-unit building we just closed last week.

It's currently rented about $650/unit per month on average across the unit mix.

We are paying 7% cap for it for a "C" area and people are saying "Mike's stupid".

But, we are already getting approved for rent increase to about $800/unit per month. By the time all is said and done, we will create over $500K in profit in the next 12 months.

I don't think half a million dollars of profit in a year on just a small building like that can be called "stupid", isn't it?

[Ben Leybovich]

Originally posted by @Scott Trench:

One interesting thing to note about low cap rates is that they actually dramatically increase the returns of a great operator buying multifamily, assuming the cap rates don't change.

Scott, here's an example: 

So, I have an LOI out as we speak. The price I am comfortable paying represents 4.8% Cap Rate on my best estimate of what the normalized financials are.

I project the NOI by the end of Y1 at just about $600,000. But, by the end of Y3 - a bit over $1M. By that time, upon my basis my Cap Rate will be around 7.7% - in a market that currently trades at 4.75% - 5%.

Thus, the $400,000 increase to the NOI should represent $8M of value at 5% Cap. And obvipously, while at 4.8% Cap there won't be much CF, at 7.7% Cap the asset will CF nicely.

This is basically the big picure.

[George Gammon]

[George Gammon]

Originally posted by @Scott Trench:

One interesting thing to note about low cap rates is that they actually dramatically increase the returns of a great operator buying multifamily, assuming the cap rates don't change.

Example: 

Apartment for sale. $400K in NOI. 4% Cap Rate. $10M Price.

You buy it with some LPs. You put down 30%, $3M, and increase rents and decrease OpEx with $2.5M in Capital improvements. Financed $9.5M in debt. Property generates $600K in NOI at the end of year 2 going into year 3. You complete this over two years and sell at the end of year 3 with a full year of NOI at the new higher level.

Well, now your asset is worth $15M at a 4% cap rate. If you and your LPs put 30% in equity, $3M, then you liquidate $6.5M net of debt, plus your ~$1.3M in cash flow, for a total of $7.8M returned on $3M in equity (and that's before loan amortization). Pretty solid to 2.5X+ your equity in three years.

Now let's try the same project at a 10% Cap rate:

$400K in NOI. $4M Price. You put down 30% - $1.2M - and increase rents and decrease OpEx with a $2.5M in CAPEX to achieve $600K in NOI in year 3. You've financed the acquisition and CapEx with $5.3M and you plan sell at the end of year 3. In this sceneario, you will generate ~$1.3M in NOI during the hold, and your equity value increases to $6M. Not factoring in loan amortization, you'd generate $700K in proceeds net of debt from the sale, and $1.3M in cash flow during your hold period. That's $2.0M returned to investors on $1.2M down. This is a far less attractive (but still good) 66% return over three years than the case above.

Certainly, low cap rates come with increased risk - when cap rates rise, the investors playing the first game will get washed. That's a risk that is understood, and why you might not want to play this game with money you can't afford to lose. But, if they stay low, major acquisitions and remodels begin to make a whole lot of sense, in ways they never will in a 10% Cap Rate environment.

Just ask @Ben Leybovich how this is working out in Phoenix for him.

 

I'll try to be as diplomatic as possible. I think this post shows the dangers of starting an investment career after 2009, not living through the 1970's, and most importantly looking at investing through the lens of possibilities without considering probabilities.

Let's start with facts. All the numbers are 100% correct. And it's a very astute observation.

The reason I have such a strong reaction when I see posts like this is because, although very well intentioned, it has the potential to lead the less experienced on BP down a road to ruin. Think about what is being said here.

Insanely high prices are an opportunity because you can go dangerously far out on the risk curve to supersize returns, or losses, by trying to find a greater fool. Note: use money you can afford to lose. And what ever you do ignore probabilities.

Why go to all the trouble and work of increasing cash flow? Why not just borrow the 3 million and buy bitcoin? Better yet, why not just borrow the 3 million and go to the nearest roulette wheel? It would only take you a couple spins to get a 2.5x return.

Of course, if I seriously suggested buying bitcoin on margin or playing roulette on margin, everyone on BP would think I'm insane. At best they'd say, "that's not investing, that's gambling." My response, of course would be, "it's not gambling if you're using money you can afford to lose..." ;)

Serious question: What is the difference between investing and gambling? Investing is having an edge, or the mathematical probability of winning. So if you take the same course of action, the more times the action is taken the greater probability you'll have of winning. Gambling is not having a probable edge...or even being cognizant of the risk and probabilities. Therefore, although the gambler may win in the short term, if they play long enough they'll always go bust.

Is the casino (house) gambling or investing? Answer: Investing

Is taking a leveraged bet on cap rates staying 4% for 3 years, under the following conditions, gambling or investing? 1. Worldwide interest rates at 5000 year lows 2. 40 year low cap rates (40 year high prices) 3. There can't be any substantial supply increases over the next 3 years (remember, the cure for high prices are high prices.) 4. Multi family occupancy rates must stay the same 5. The US, currently in the longest period without a recession in it's history, with the yield curve almost inverted, which predicted the last 7 recessions. See chart

After looking at the chart above, given current economic conditions, do the odds of coming out ahead on the 4% cap rate bet, increase or decrease the more times you place the bet? Decrease? Then it's gambling.

The odds of hitting red on a roulette wheel 2 times in a row (about what you need to realize a 2.5x return) are 1 in 4.24. Given the land mines listed above, which would most likely derail the 4% cap apartment gamble, are your odds better or worse than 1 in 4.24?

The fact that, given a more complete picture, you actually have to think for a second which has better odds, the 4% cap rate greater fool bet or the 2 spins on a roulette wheel, is in a nut shell, why I take the time to post on BP.

George

[Jim K.]

@Michael Ealy

When you start with huge disadvantages, and I think your analysis is very spot-on there about it for Millennials, there's more of a tendency to become institutionalized in tenant mentality, the mindset of people who pay rent and expect a certain amount of free maintenance versus people who pay a mortgage and understand maintenance is all on them.

It's all well and good to imagine yourself taking on the many do-it-yourself maintenance challenges of home ownership at 25, 30, 35. It's quite another to decide to do it at 40-45, in additional to all the other challenges these young people today are going to be facing at that age. I think we have to take that, as well as the ever-aging housing stock statistics, more seriously in these discussions about what the lifelong housing choices of the Millennials are going to look like. The median age of an American house is 37. How many Baby Boomers and Gen Xers bought a first primary residence that was 37 years old to start with? And what was the relative build quality of homes built in 1955 for the Baby Boomer first buying in 1977 and the homes built in 1966 for the Gen Xer first buying in 1994 versus the homes built during the tract slop years of the early 1980s for a Millennial looking to buy today? Nobody's talking about this seriously.

I also feel that there are more and more young people out there who see the manual work of home maintenance as beneath them, with an additional, perhaps even larger group of people who see it as too specialized for them. The rigid mentality that "it takes a professional" or "I'll focus on what I'm good at, and let others handle what they're good at" looks more and more like Millennial brainwashing every day to me when it comes to home maintenance.

[Ben Leybovich]

Originally posted by @George Gammon:

Originally posted by @Scott Trench:

One interesting thing to note about low cap rates is that they actually dramatically increase the returns of a great operator buying multifamily, assuming the cap rates don't change.

George, you are right. If rents dip down 30% and cap rates inflate to 10%, my business model will be in trouble. Worthwhile to note that in the MSA I operate, the rents dipped by about 8% at the bottom of the great recession, and cap rates came up to 6.5% - 7%, depending on submarket.

That said, to experience what you are proposing we would have to encounter an economic downturn much more aggressive than the one that began in 2008.

I have to be honest - I don't see it...

We have to draw the line somewhere in the sand. Let us be a little logical.

Having said this, I would only do what I am doing in perhaps 3 MSAs in the country at this point in the cycle. The majority of the country, not so much.

[George Gammon]

@Ben Leybovich agreed "let's be logical"

First, I'm not responding to your biz model specifically, I'm responding to the hypothetical numbers used by the poster.  I believe his name is Scott? 

Based on his numbers you'd be completely wiped out if rents decreased and cap rates went to 7% (buy asset for 10 mil, 3 mil down, with 400k cash flow at 4% cap)

But let's look at the "logic" behind your model, which I assume is taking pooled money, leveraging it, buying multifam at a target of 4.8%cap, increasing cash flows and flipping them?  Please correct me if I'm wrong.

If that is somewhat close, your model lives and dies by interest rates.  So my question is, I'm sure you means tested your model using the 1970's.  How did it perform?  Were you in trouble? 

Next, it's only logical to look at the data.  As you know, inflation is a combination of money supply and velocity.  Let's look at money supply.

Next let's look at US debt.

And of course history shows us the only way to get out of a debt problem is 1. default or 2. inflation.  We've all been listening to the Fed over the years raise their inflation target from 2% to 2% average to a floor of 2%.  This is of course because the government has to inflate away the value of the debt.  

Here's a chart of sovereign debt worldwide.  

Pretty obvious why governments want inflation so badly...

But let's get back to interest rates specifically.  My guess is your model would struggle if the 10 year went to 7%+?  Which is where it's been roughly 35% of the time since 1960.  See chart

But we've also been in a 40 year bull market in rates.  Is there any chance that reverses?  See chart

I'd like to point out that rates go down...but they also go up.  Usually in very long cycles, of generally 30 years.  We're at 39 years on the current cycle.  

My point is, using "logic" as you suggest, the probability of 1970's inflation, and or interest rates going up, way up, is higher than zero.   Most likely high enough to justify a means test like you obviously did with the GFC.   

If you've already done the 1970's inflation and 7%+ interest rate means test, or do it in the future, I'd love to hear about the results.

George 

[Ben Leybovich]

Originally posted by @George Gammon:

@Ben Leybovich agreed "let's be logical"

George, you are very smart.

If the rate went to 7%, the model would still be cash flow positive on a 10-year hold. Having said this, Chatham Financial, one of the largest insurers of interest rate, perhaps the largest. is forecasting 1-month LIBOR dipping down to about 1.5% by 2021, and coming up to a bit over 2% by 2029. 

Could they be wrong? Yes. But, their business is to study the issue of interest rates. As an investor I am required to make lots of judgement calls, and this is on thing I will defer to the pros.

The bigger issue is this: your argumant doesn't take into account the real economy in a couple of ways. First, if rates are going up to 7%, the economy is in the shitter. In which case, what happens to those deals in Kentucky, Ohio, and Alabama that are trading at higher cap rates, where there already are no job growth, population growth, returement population growth, or Millenials who want to live there? Who's going to pay the rents if the rates are at 7% and the economy is in the shitter? I bet they'll be doing much worse than me.

Secondly, we've seen a run-up in the rates recently, yet the cap rates contonued to compress. Why? Because of fundamentals. Home ownership rates are back down to historical norms of 64%, and we dodn't build enough apartments to accomodate the rest. There is demand and it can't be replaced with Class A new construction...

Lastly, I am not exactly the smartest kid in class, but for what it's worth I am of the opinion that 2008 was an anomaly that we are not likely to see again in our lifetimes. The pricing we saw was an anomaly. Construction costs are up and continuing to go up, thus the rebuild costs + risk premium is continuing to go up.

So, as I see it, the risk is never zero, but we have to draw a line somewhere. If we have armaggedon, I and everyone will be in trouble. Short of completely sitting on the sidelines and waiting for 2008 to come again, I'd rather pay a 4.8% Cap in a growth market that is a tech/banking/healthcare hub than pay an 8% cap in most other places. Of course, only value add, but this goes without saying.

[Mike Dymski]

@George Gammon great feedback.  We have been aware of the risks for five or so years now.  I am more interested in what people are doing about the risks.  Moving six, seven, or eight figures of net worth into cash is not an option for most people.  I am interested in how you and others are investing to mitigate the risks.  I have been excruciatingly selective, re-allocating from value plays into cash flow plays, using prudent debt, and always adding value.

[Lam N.]

Originally posted by @Alan Grobmeier:

A number of millennials can't afford a date according to this article.  Not sure how you can buy a house if you can't afford a date?

https://www.usatoday.com/story...

Millennials come in all shapes and sizes. Husband and I are millennials. We flipped houses for a few years and now we are buying and holding rentals. Some millennials we know spend every penny they earn traveling the world. Some we know who are always broke and can't even travel or buy. 

I know we have certain reputation to the older generations. I'm just saying we are a very diverse group. 

[Mike Dymski]

Originally posted by @Lam N.:

Originally posted by @Alan Grobmeier:

I know we have certain reputation to the older generations. I'm just saying we are a very diverse group. 

Generations don't have reputations...they are cohorts that have economic and social patterns.

Getting defensive only validates these patterns.

And it was my generation, Gen X, that created many of the challenges that some millennials face by our permissive parenting.  The finger is pointed in the wrong direction...we are the problem.

Alan, that article was hilarious.

[Lam N.]

Originally posted by @Mike Dymski:

Originally posted by @Lam N.:

Originally posted by @Alan Grobmeier:

I know we have certain reputation to the older generations. I'm just saying we are a very diverse group. 

Generations don't have reputations...they are cohorts that have economic and social patterns.

Getting defensive only validates these patterns.

And it was my generation, Gen X, that created many of the challenges that some millennials face by our permissive parenting.  The finger is pointed in the wrong direction...we are the problem.

Alan, that article was hilarious.

 Actually, I didn't mean to be defensive. And yes, I agree with the general patterns of behavior of each generation. In a way, we do fall into that pattern. Husband and I love to travel. Unlike a lot of other millennials, we don't spend every penny we earn to travel. 

But yes, I agree with you. 

[Alan Grobmeier]

@George Gammon, great info & great post.  

However, with 21T in debt, state & local pensions defaulting, can our government afford anything other than ZIRP without causing another Great Recession?

I see low interest rates ‘forever’ on the horizon.  How can they do anything else without causing chaos?